November move on PNs pays off, 100 FIIs register with Sebi

About 100 foreign institutional investors (FIIs) and twice as many sub-accounts have registered with the Securities and Exchange Board of India, or Sebi, since November, signalling foreign investors’ increasing appetite for Indian stocks as well as the Indian capital market regulator’s promptness in clearing applications.

Sebi had imposed restrictions on the use of participatory notes (PNs) to invest in Indian stock market in mid-October, but promised to ease the application process for unregistered entities participating in India’s capital market. This step, according to Sebi, was taken to increase transparency in Indian markets by monitoring the credentials of all foreign investors in the domestic market.

Participatory notes, a popular investment instrument among unregistered foreign investors, are contract notes. Registered FIIs issue these notes to their clients who wish to take exposure in Indian stocks without directly registering with Sebi. The FIIs purchase Indian securities through their account and then issue an offshore derivative of these securities to the clients for a fixed fee.

The number of FIIs registered in India toward the end of 2006 was well below 1,000. However, at the end of 2007, this number went up to 1,219, at least 20% increase. The registered sub-accounts of these FIIs also went up significantly to 3,644.

“We are still investing through participatory notes, but the capacity is constrained,” says Tarun Gandhi, an executive at investment fund house Spinnaker Capital Group, which received a FII license on 7 January.

According to Gandhi, his firm may continue to invest in India through PNs. “It takes away lot of administrative hassles,” he said. “On the other hand, investing yourself is a cumbersome process.”

This is because when a foreign entity or a hedge fund invests in India through PNs, all the paper work and settlement is taken care of by the PN issuer (mostly large brokerages), for a nominal fee. On the other hand, if these entities are to invest and maintain a portfolio under their own account, they have to take the onus of preparing the transaction-related documents.

According to the announcements made by Sebi after the clampdown on PNs, the time involved in processing an FII application was significantly reduced while also scrapping the practice of re-application by registered FIIs after a stipulated period to renew their account.

Anoop Sethi, Singapore-based executive of US-based hedge fund Indus Capital Partners, which focuses on investments in Asian stocks, says that though many foreign investors have registered with the Indian regulator, there is no real difference in the application process. Sebi cleared Indus’ application for FII status on 16 November.

“Many of these newly registered FIIs (after November) would have been eligible to get registered earlier as well, but they were investing through PNs because of convenience,” said U.R. Bhat, managing director of Dalton Capital Advisors (India) Pvt. Ltd, the Indian arm of a global hedge fund group. “Getting registered as an FII does not essentially mean that the firm will immediately start investing in India. When the PN window was closed, many firms chose to register to keep open the option of investing in India.”

Sebi had opened doors for FIIs to enter Indian stock market in December 1993. Since then, FIIs have invested $66.8 billion in Indian equities net of sale. In 2007, FIIs invested a record $17.2 billion (Rs67,596 crore) in Indian markets.

According to foreign fund managers, erstwhile PN investors are now rushing to get registered as FIIs but they have not started purchasing Indian stocks through newly registered accounts. In the first five trade sessions in 2008, they have invested a net $478 million in Indian equities.